Leading business and financial adviser Grant Thornton UK LLP has today published a summary of its responses and recommendations to the Competition and Markets Authority’s (CMA) statutory audit market study.
Announced on 9th October, the CMA’s review aims to better understand whether the statutory audit market is working as well as it should, with a particular focus on issues relating to: choice and switching, the long-term resilience of the sector and the incentives between audited companies, audit firms and investors.
Grant Thornton’s submission builds on the firm’s earlier recommendations in relation to audit market reform, particularly as relate to the development of an independent body to appoint auditors and the non-audit services that should not be provided by the auditor. Grant Thornton does not believe that structural reform is needed, even to the extent of ring-fencing audit from advisory services within a firm, and draws attention to the fact that some potential reforms could have the unintended consequence of worsening the competitive landscape.
Jon Roberts, head of assurance at Grant Thornton UK LLP, commented: “We believe that competition in the audit market for large companies and public interest entities (PIEs) is not functioning well and that the measures introduced following the last Competition Commission investigation have not been as impactful as would have been desired. The CMA’s investigation reflects many of the same concerns that led to our unique position of withdrawing from tendering in the FTSE350 audit market, due to its broken nature.
“We see this CMA study as a chance to better align audit services with core public interest considerations and believe we have a useful perspective to contribute. Even though we may be considered to be potential beneficiaries of reform, we support the objective of reducing concentration in the FTSE 350 audit market because we believe in the principles of effective competition and the consequent benefits on audit quality. We note that the CMA acknowledges that audit scope is also in need of attention but that is not the primary purpose of its study. Considering broader reforms to audit scope, such as increased work on a company’s viability and its anti-fraud arrangements will be important questions for any further reviews on the audit profession in future to answer.”
Executive Summary of Grant Thornton’s Response to CMA’s Audit Market Consultation
Grant Thornton agrees that competition in the supply of audit services to PIEs in the UK is still not working well. The remedies adopted at the end of the market investigation carried out by the CC (the “CC Remedies”) may have resulted in some increase in companies tendering for and sometimes switching their auditor on a more regular basis. However, any increase in switching has been limited to switching between the Big 4. It has not resulted in non-Big 4 audit firms winning a large number of FTSE 350 audit mandates.
This lack of effective competition was a central factor in Grant Thornton’s decision, taken earlier in 2018, to withdraw from future tendering for the provision of audit services to FTSE 350 companies. We felt that buyers’ predisposition to the Big 4 meant that we were not being permitted to play on a level playing field and so took a commercial decision to stop investing in what were very high cost tenders that offered little possibility of success.
These are problems specific to the UK large company audit market, which must be the focus of remedial measures. Grant Thornton shares the view of the CMA that there is unlikely to be one complete solution. The issues identified in the Invitation to Comment (ITC) are multi-faceted and a range of measures to address them is likely to be required. We welcome the CMA’s caution with regard to potential unintended consequences. In particular, mid-sized and smaller (and particularly privately-held) companies operate in a different market context to large PIEs. The CMA should not impose measures which disturb that well-functioning market or act as barriers to expansion for mid-size and smaller companies.
Reform must focus on strengthening the independence of auditors of UK PIEs and on removing the biases in favour of the Big 4 that are not driven by quality. This will better serve stakeholders and the public interest. We consider that, in larger companies, “stakeholder” should extend beyond management and shareholders, also to cover pension holders, employees, customers, suppliers and local communities served by the company.
Grant Thornton has the technical capability, scale and capacity to undertake and deliver high quality audits for many FTSE 350 companies today including those with wide international operations. Nevertheless, we recognise that the largest and most complex companies, which may have systemic importance on an international scale, will require an auditor that can match that size and complexity, or two or more auditors acting under a shared mandate.
Grant Thornton does not consider that separating the audit and non-audit practices of the Big 4 would be an effective remedy. Audit quality is enhanced by the broader resources and insights that are available to support the audit function on an “as needed” basis in a multi-disciplinary firm. Simply splitting out audit is unlikely to solve all the concerns: rather it would create a group of Big 4 audit-only firms, with the same level of market concentration and the same buy-side biases in play. Some mid-tier firms may leave the market, rather than split their business to compete for PIE audit mandates. Although splitting out audit from non-audit business would partially address conflicts of interest and independence, we support simpler solutions.
While Grant Thornton benefits commercially from providing both audit and advisory services to clients, we see value in prohibiting firms from receiving non-audit fees from PIE audit clients. Regulatory changes which have tightened controls over the selling of both audit and non-audit services to PIEs have reduced the practice, but auditors continue to provide non-audit services to their PIE audit clients, often to the value of around 40 per cent of the audit fee (and up to a limit of 70%). Importantly, there is a perception that sales of non-audit services create conflicts of interest: a clear ban may serve the public interest by providing wider stakeholders with reassurance and promote trust in the industry. However, there are certain services which are currently defined as ‘non-audit’, but are compatible with and, indeed, complementary to, the provision of high-quality audit. Any ‘ban’ on firms receiving non-audit fees from such clients would need to be carefully defined to ensure that these positive services are allowed to continue. It would be unfortunate if any action by the CMA resulted in firms only being able to offer audits which were less effective.
Grant Thornton does not consider that the introduction of a market share cap in relation to the percentage of audits of FTSE 350 companies carried out by the Big 4 is, by itself, a useful tool for dealing with the concerns that have been identified. In particular, it is not clear to us how this would be made to operate without allowing the Big 4 to cherry pick the most attractive and profitable audits. Grant Thornton does consider that there may be some benefit in setting an aspirational market share target for an independent auditor appointment body (see below) to aim for.
Grant Thornton does consider that there are advantages to joint or shared audits. This mechanism is used in countries such as France, where there is better market stability, with fewer high-profile failures and greater public trust in auditing. It offers the ability to draw on a wider range of technical knowledge and experience, promotes better quality outcomes, ensures a higher level of rigour and independence and generally results in a more dynamic market in terms of the number of firms able to provide effective audit services. Joint audits could be set up in a number of ways – we support a ‘shared’ audit model. We acknowledge that joint audit has been criticised and resisted in the past by the buy-side, but we look forward to discussing this again with the CMA. In particular, Grant Thornton considers that the introduction and use of joint audit is something that could be supported by an independent auditor appointment body with a public interest duty (see below).
Grant Thornton has previously called for an independent auditor appointment body. We note that the use of an independent auditor appointment body has been embraced in the UK public sector. An equivalent mechanism for the appointment of auditors to certain FTSE 250 companies could have a positive effect in terms of promoting independence and addressing potential bias in the procurement of audit by large companies in the UK. Although a significant change to the current system, this would send a clear signal that the UK is serious about market reform and ensuring that the firm (or firms) appointed to audit a large company is the firm (or firms) that will carry out that role most effectively, balancing the interests of all the various stakeholders and placing the public interest at the heart of the selection process. Such an arrangement could also deal with non-audit service procurement in a fully independent manner addressing current concerns over conflicts of interest in this area (a prohibition on selling non-audit services to PIE audit clients may also address this). We do think that private audit firms will provide the best quality audit in a well-functioning market: Grant Thornton does not support the nationalised provision of audit services.
Effective reforms that increased competition and auditor independence in relation to PIEs would be strongly supported by Grant Thornton and would encourage more non-Big 4 firms to tender for audit for FTSE 350 companies. We consider that a successful outcome to the CMA’s current market study would be one where:
- audit quality overall in the FTSE 350, as measured by the FRC, improves consistently
- 10-20% of the companies in the FTSE 350 are being audited by non-Big 4 firms within three to four years
- there is wider stakeholder engagement with audit
- auditor independence (and the perception of independence) is strengthened
- public trust and confidence are restored.